The issue before the Bombay High Court was whether the FDI in Real Estate Sector with fixed returns is permissible or not? In 2005, the Government liberalized the policy of Foreign Direct Investment allowing FDI into a number of sectors including real estate. However, in the Real Estate Sector, foreign investment was permitted only in the form of direct equity investment or instruments which could be compulsorily or mandatorily converted into equity. What was specifically prohibited was investment in any debt instrument and investment in optionally or partly convertible debentures.
In the case before the HC, Vinca Developers Private Limited, one of the Group Companies of Hubtown Limited—promoted by Vyomesh Shah and Hemant Shah-- was executing a Slum Rehabilitation (SRA) project at Wadala, Mumbai for which a Foreign Investor, Netherlandse Financierings Maatschappij Voor Ontwinkkelingslanden N.V (FMO), a bilateral private-sector development bank was interested in equity participating. FMO had invested in Compulsorily Convertible Debentures issued by Vinca. The CCD funds were invested in projects approved by FMO and to purchase optionally convertible debentures (OPCDs) issued by Amazia Developers and Rubix Trading, two wholly-owned subsidiaries of Vinca.
IDBI Trusteeship Services Ltd was appointed as debenture trustees of debentures issued to Vinca by Amazia and Rubix. Hubtown and its promoters own 90 percent shares of Vinca. The FMO holds 10 percent shareholding in Vinca.
Hubtown executed a deed of corporate guarantee in 2009 in favour of IDBI Trusteeship against any liability arising from the OPCDs, "as a matter of comfort'' its lawyers later said.
The SRA project was stalled and delayed due to various reasons, mainly due to inordinate delays in obtaining approvals. It led to invocation of guarantee in August 2012, by IDBI which alleged defaults.
Later in 2013 when Hubtown refused payment to IDBI and withdrew the guarantee on the grounds that an Indian entity could not issue one to a non resident entity under the FDI rules, the Indian company IDBI rushed to the HC for recovery of its dues under the guarantee.
But after hearing senior counsel on both sides, including Virendra Tulzapurkar forIDBI Trusteeship and Janak Dwarkadas with Dinyar Madon for Hubtown along with Gaurav Joshi and Nishit Dhruva, the judge held that the "whole structuring and the guarantee was prima facie illegal and unenforceable.''
Justice Kathawala said, "I am prima facie of the view that the structure of routing FMO's FDI amount of Rs. 418 crores to Amazia and Rubix through the newly interposed Vinca (as the nominal recipient of the FDI) was a colourable device structured only to enable FMO to secure repayment (through Vinca) of its FDI amount and interest contrary to the statutory FEMA Regulations and the FDI policy embodied therein, which only permit FDI investment in townships/real estate development sector to be made in the form of equity (including Compulsorily Convertible Debentures) and preclude any assured return.''
The judge also observed that the guarantee through ostensibly in favour of Vinca, an Indian Company, was part of the illegal structure/and was given to ensure that FMO received back its FDI amount with interest through Vinca. The Guarantee was therefore part of the aforesaid illegal structures/scheme and therefore prima facie illegal and unenforceable.
The HC accepted Hubtown's stand that several triable issues were raised by it in the dispute and while the suit for further adjudication and framing of issues later this month, dismissed the company petition filed by IDBI.
Nishit Dhruva, partner of MDP told TOI when contacted later, "As a matter of fact, no permission could be obtained for a debt investment by a foreign entity in the real estate sector even under the approval route. The issuance of non-equity instruments such as types of preference shares, non-convertible or optionally convertible or partially convertible debentures would be considered to be External Commercial Borrowers, which are not allowed in the real estate sector. An instrument which gives an assured return to a foreign investor or is optionally convertible would not be permissible as per the existing FDI policy. Even the RBI does not have authority to grant such permission. Similarly, giving up of guarantees providing for assured returns is also prohibited''.